Starting the new quarter yesterday with a pullback in the markets was not exactly what most expected, but not a huge surprise either. After such a strong run so far in 2013 and major indexes like $SPX and $INDU sporting new All Time Highs (on close) to end the quarter, most are calling for an imminent correction….or maybe more. Much, much more for some, but we will save that for a different post. Yesterday it got loud as the $IWM gave up the most ground after leading much of the way higher. All these are signs to pay attention to, but none have offered enough damage to turn the tide yet? Why not?
Then I see this post from my friend @chicagosean:
The chart in his post just confirmed what he was saying and my own thoughts. It is very rarely this easy. That got me thinking, if a correction is what everyone wants, what is the path that would frustrate them the most?
Here is what I came up with:
The markets have already made new highs and now have the challenge of holding them. That is one of the reason that many won’t buy until the market moves at least 3% above the trigger. The idea is that once you get 3%+ move over the trigger then your chances of having a false move drop greatly. Personally I haven’t ever seen any research that shows this decisively, but it is pervasive in investing books. So, that tells me that those wanting a pullback are hoping it comes before that 3%. If that is the case, I believe we are likely to move about 3.5% above the 1565 close which would be about 1620. That satisfies some measured moves I have seen floating about, breaks 1600 and is likely to get everyone excited. Now those pullback players are seeing the 3% rule and sweating profusely.
That is when they jump in. I mean they waited for 3% confirmation, what could go wrong? That would also be about the time that the Daily, Weekly, and possibly Monthly charts could all line up in Overbought territory. It would be a good time for us to actually get that correction. If it comes 3.5% above the highs, then a 4-5% drop would put us just below the breakout point at which time many breakout players would be getting stopped out.
So where does that put us? Those who missed the rally and bought the breakout just got stopped out! now they are nervous to buy the flush that is created when the stops are ran. Therefore we end up with the situation where those who so desperately called for the correction are afraid to buy it now that it is finally here because they just got rooked by Mr. Market on their stops and now believe we are in for a big failure and will go much lower. That would be the point these markets will likely be a phenomenal buy.
Never forget the markets often take the path that frustrate the most. Could this scenario be it?
Good Luck, it is there for the making!